Question

# 1/ A company issued 10.0%, 5-year bonds with a par value of \$160,000. The market rate...

1/ A company issued 10.0%, 5-year bonds with a par value of \$160,000. The market rate when the bonds were issued was 11.0%. The company received \$153,969.90 cash for the bonds. Using the effective interest method, the amount of interest expense for the second semiannual interest period is:

Multiple Choice

\$8,000.00.

\$8,494.10.

\$8,468.34.

\$16,000.00.

\$16,962.44.

2/ A corporation issued 8% bonds with a par value of \$1,080,000, receiving a \$36,000 premium. On the interest date 5 years later, after the bond interest was paid and after 40% of the premium had been amortized, the corporation purchased the entire issue on the open market at 99 and retired it. The gain or loss on this retirement is:

Multiple Choice

\$0.

\$10,800 gain.

\$10,800 loss.

\$32,400 gain.

\$32,400 loss.

Solution 1:

Bond initial market price = \$153,969.90

Market rate = 11%

Interest to be recognized for first semi annual period = \$153969.90*11%/2 = \$8,468.34

Interest received for first semi annual period = \$160,000*10%/2 = \$8,000

Balance of bond after 1st period = \$153,969.90 + \$8,468.34 - \$8,000 = \$154,438.24

Interest to be recognized for 2nd semi annual period = \$154,438.24*11%/2 = \$8,494.10

Solution 2:

Premium on bond = \$36.000

Premium amortized up to 5 years = \$36,000*40% = \$14,400

Balance premium = \$36,000 * 60% = \$21,600

Corporation purchased entire issue in open market at 99, hence total payment made for bond at retirement = \$1,080,000*99% = \$1,069,200

Gain on retirment = \$1,080,000 - \$1,069,200 +\$21,600 = \$32,400

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